Tuesday, November 11, 2008

More on consumption taxes...

One of our readers brings up two important and thoughtful critiques of a consumption tax, which was discussed in a previous post:
"Though a high deductible - like $30,000 - does alleviate any burden the consumption tax might have for the lower and lower middle classes, the deductible is not close to high enough to compensate for the average spending of the middle class, who it seems to me would be most effected by such a policy. The real winners in this type of scenario are the upper and upper middle classes, making this system work in a quasi-regressive manner...

Furthermore, though savings is beneficial on the individual level, spending is what drives our economy and creates both jobs and wealth. Because of the proposed deductible, there would be no tax incentive for people with incomes below the deductible to save"
It's hard to say, a priori, how much the consumption tax described by Robert Frank would encourage savings among lower income individuals. This plan will not help people who have to spend all of their income just to get by. But for people who can save a little money but don't have access to 401K plans, this could be helpful. Additionally, for middle class families who do have retirement plans, a consumption tax might encourage savings above the tax-free limits and will reduce the cost of medium-term savings.

While consumer spending is important for any economy, it is not the only thing that "creates jobs and wealth". Savings and investment is crucial for future growth and for preventing poverty. Laurence J. Kotlikoff, writing in the Concise Encyclopedia of Economics, explains the effect of low savings rates on the baby-boomer generation:
"Compared with their parents, baby boomers can expect to retire earlier, live longer, rely less on inheritances, receive less help from their children, experience slower real wage growth, face higher taxes, and replace a smaller fraction of their preretirement earnings with Social Security retirement benefits. Unless baby boomers change their saving habits substantially and relatively quickly, they may experience much higher rates of poverty in their old age than those currently observed among U.S. elderly."
I would add that encouraging savings (or, more accurately removing disincentives to savings) is important for social mobility. Education costs are rising well above the rate of inflation, while at the same time the returns to education are as high as they have ever been. We want to make sure that savings is no more expensive than it needs to be.

And education yields positive returns to society. Underemployed and undereducated individuals represent one of our country's most wasted resources. More savings means more education, which ultimately means more productivity and wealth creation.

Thanks for the comment!

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